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BUY-SELL AGREEMENT HANDBOOK
times an active owner (as opposed to a passive investor) who wants to retire or stop working for the
company also wishes to retain all or part of his ownership stake. In some situations this may be just what
the continuing owners want, since this allows them
to keep the retiring owner’s capital in the business
and means they don’t have to come up with money
for a buyout. But in other situations the remaining
owners may not like this arrangement, reasoning that
they don’t want a passive investor to reap the benefits of their continuing hard work.
One thing is sure, it’s hard to know how one
owner’s deciding to retire or quit will be viewed
in the future. A lot will probably depend on
whether the departing owner and the remaining
owners are on good personal terms. But just
because you can’t predict the future doesn’t mean
you shouldn’t prepare for it by providing options
in the buy-sell agreement.
On balance it’s usually best to provide that,
when an owner quits her active duties, whether
as an officer or employee, the company and the
continuing owners have the option to purchase
her interest—in other words, to force the retiring
owner to sell his interest.
If you doubt this, consider what might happen
if a departing owner stops working for your business under less-than-amicable circumstances and
is poised to make trouble for management. Even if
circumstances are initially friendly, tensions may
eventually arise between the active owners, who
may be working long hours to build up the company, and an inactive owner, who may still want
to have a say in things and retain her right to a
share of the profits.
development issues. As a result, Mark quits to
follow his own dreams.
In the absence of a buy-sell agreement, Mark
can—and does—refuse to sell his minority
interest to Andromache and Eddie, apparently
believing that even though they are not as
farsighted as he is, Scripts Are Us is likely to
enjoy a profitable future. Unfortunately, Mark
doesn’t go quietly into the night. Instead,
Mark’s continual kibitzing becomes a constant
annoyance to Andromache and Eddie, who
particularly resent his periodic demands to
inspect the company’s books. Finally, after
several nasty spats at shareholders’ meetings
over the reinvestment of profits, Mark brings a
lawsuit against Andromache and Eddie, claiming they breached their “fiduciary duty to him
as a minority shareholder.”
No question that Andromache, Eddie and Mark
would have been far better off if, at the time their
business was formed, they’d adopted a buy-sell
agreement covering the eventuality that one of
them might cease to be active in the business—
specifically, one that provided the company and
the continuing owners with an option to buy a
retiring owner’s interest.
Such a provision doesn’t obligate the company
or the continuing owners to purchase the departing owner’s interest, but it gives them the option
to decide what to do in the future. We include a
clause that provides for this in our buy-sell agreement. It’s called an “Option to Purchase” clause,
and it is shown in Excerpt 1, below.
Worksheet. If you are interested in giving
EXAMPLE: Andromache and Eddie leave their
management positions at a large software
company to form a small custom-programming
shop (Scripts Are Us). They convince a programmer, Mark, to work with them by offering
him a minority interest in the new company.
After two years, during which Scripts Are Us is
modestly successful, Mark and the majority
owners no longer see eye to eye on product
the company and the continuing owners
the option to buy a retiring owner’s interest,
check Option 1 on your worksheet now. (Section
III, Scenario 1.)
How much of an owner’s interest can be
bought? Our agreement allows the
company and continuing owners to buy any or all
of the retiring owner’s interest. For example, if the
PROVIDING THE RIGHT TO FORCE BUYOUTS
3/7
Section III: Providing the Right to Force Buyouts
Scenario 1. When an Active Owner Retires or Quits the Company’s Employ
Option 1: Option of Company and Continuing Owners to Purchase a Retiring
Owner’s Interest
(a) When an owner voluntarily retires or quits the company’s employ, he or she is deemed to
have offered his or her ownership interest to the company and the continuing owners for
sale. The company and the continuing owners shall then have an option, but not an
obligation (unless otherwise stated in this agreement), to purchase all or part of the
ownership interest within the time and according to the procedure in Section IV,
Provision 1 of this agreement. The price to be paid, the manner of payments, and other
terms of the purchase shall be according to Sections VI and VII of this agreement. An
owner who stops working for the company is referred to as a “retiring owner” below.
Excerpt 1
company and continuing owners can afford to
buy only half of the retiring owner’s interest, they
can do so.
Not for silent investors. If your company is
owned by both inactive, “silent” investors
and actively participating owners, this buyout
option may not suit your needs. (If an investor
was not working in the first place, retirement
should not change his situation with regard to the
company.) Since most of our advice is tailored to
small businesses where the owners are active in
the business, we don’t deal in detail with the
special needs (or problems) of “silent” investors.
If you face this situation, be sure to have an attorney look over your agreement. We cover finding
expert help in Chapter 10.
2. Right of Departing Owner to
Force a Sale
Rather than having trouble forcing a departing
owner to sell out, it’s far more likely that, when a
co-owner decides to leave a business, she’ll be
anxious to sell her interest, either to an outsider
or back to the company or the continuing owners. If she has no luck finding an outsider to buy
her interest, she’ll probably approach the company and the continuing owners. Sometimes the
company or the continuing owners will be happy
to buy the departing owner out—perhaps the
company is now quite profitable and the remaining owners will be pleased to increase their
shares. Or, perhaps the departing owner is leaving precisely because she wasn’t getting along
with the other owners and they’re glad to see her
go, even if it means they have to pay her for her
share of the company. In these and other workable circumstances, an ownership buyout is normally a fairly straightforward situation. Once the
deal is done, it’s business as usual with one less
owner.
But it’s not always so simple. What if the remaining owners don’t want to, or can’t afford to,
buy a departing partner out? In this situation, the
question often becomes: Can the departing owner
force the continuing owners to purchase his share
of the business? As you’ve probably guessed, the
answer is: not unless there is an agreement requiring it. Before you adopt a buy-sell provision
that will deal with this situation, you and your co-
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BUY-SELL AGREEMENT HANDBOOK
owners should ask yourselves a simple question:
Do you want an owner (who, after all, could be
any of you) to be able to force the company and
the continuing owners to buy her interest if she
decides to leave?
Especially if you’re a minority owner, your
answer is likely to be yes. It can be hard enough
to sell a majority interest in a small business, but
it can be next to impossible to sell a minority
stake—or even a 50% share.
EXAMPLE: Luis and Marta are equal partners in
a successful burrito shop that caters to the
business lunch crowd. After a few years of
long hours and hard work, Marta decides she
wants to sell her interest to Luis and get a job
where she can work shorter hours and spend
more time with her kids. Luis, who feels personally abandoned, is reluctant to further
stretch his already tight finances and is worried
about competition from a new deli that is
about to open in the area. He shrugs and says
he’s not interested in buying Marta’s interest.
Since she and Luis didn’t sign a buy-sell agreement, Marta has to search for an outside buyer.
She hires a business broker and spends money
advertising, but finds out that no one wants to
buy only half of a burrito shop. Potential buyers want the whole enchilada or nothing. After
looking for a buyer for months, Marta finally
ends up selling her share to Luis’s cousin for
far less than it was worth.
One way to deal with a problem like Marta’s is
to include a buy-sell provision that requires either
the company or its remaining owners to buy out
an owner who wants to leave. This type of
clause—we call it a “Right-to-Force-a-Sale”
clause—can protect a departing co-owner (who
may be leaving as the result of personal or financial distress) by guaranteeing a buyer for his ownership interest. The clause included in our buysell agreement that covers this option is shown in
Excerpt 2.
The effects of a required buyout on the company can be buffered by providing financial disincentives to leaving early, by requiring advance
notice of a departure and by using installment
plans, as discussed below.
Worksheet. If you are interested in giving a
retiring owner the power to force a sale of
her interest to the company and the continuing
owners, check Option 2 on your worksheet now.
(Section III, Scenario 1.) You can include both
Option 1 and Option 2 for retiring owners in your
agreement. It’s possible, and perfectly valid, to
include both Option 1—the option for the company and continuing owners to buy out a retiring
owner—and Option 2—a retiring owner’s right to
force a sale—in your agreement.
All or none of the interest can be offered.
Note that our Right-to-Force-a-Sale provision
does not allow a retiring owner to require the
company and the continuing owners to buy a
portion of her interest. A retiring owner can
request only that the company and continuing
owners buy all of her interest or none of it.
Not for silent investors. Generally, if your
company is owned by both inactive, “silent” investors and actively participating owners,
this clause will not suit your needs. (After all, if
an investor was not working in the first place, retirement should not allow him to force a buyout.)
a. Providing Disincentives to Leaving Early
No question, this type of forced buyout provision
allows all co-owners lots of leeway in deciding if
and when to leave the business. But personal
flexibility may not necessarily be a good thing for
your company or for the owners who are left
behind when one owner quits. Leaving aside the
fact that it may weaken all owners’ commitment
to their company, it creates the real possibility
that one or more owners will demand to be
PROVIDING THE RIGHT TO FORCE BUYOUTS
3/9
Option 2: Right of Retiring Owner to Force a Sale
(a) When an owner voluntarily retires or quits the company’s employ, he or she can require
the company and the continuing owners to buy all, but not less than all, of his or her
ownership interest by delivering to the company at least 60 days before his or her
departure a notice of intention to force a sale (“Notice of Intent to Force a Sale”). The
notice shall include the date of departure, the name and address of the owner, a
description and amount of the owner’s interest in the company and a statement that the
owner wishes to force a sale due to the owner’s retirement as provided in this provision.
The procedure for purchase of the ownership interest shall be according to Section IV,
Provision 2 of this agreement. The price to be paid, the manner of payments and other
terms of the purchase shall be according to this section and Sections VI and VII of this
agreement. An owner who requests that his interest be purchased is referred to as a
“retiring owner” below.
Excerpt 2
cashed out precisely at a time when the company
is doing poorly or needs every bit of its cash for
another purpose, such as expansion.
Recognizing that a forced buyout may be
highly problematic, you may decide to head in
the opposite direction and say that a departing
owner can never force the company or other
owners to buy him out. But, of course, that brings
you right back to the worry you started with: the
possibility of getting stuck forever owning a share
of a business you no longer want, or selling your
share at a huge discount because you’re so
desperate to get out. This prospect is so unattractive—and potentially unfair—that it can lead to
horrendous results.
EXAMPLE: Dakon and Jed each contribute
$20,000 of their savings to open a climbinggear store in Colorado. To purchase inventory
and cover other start-up costs, they also take
out a bank loan. From the start they are
successful enough to pay the bills and eke out
small salaries, but not much else. Near the end
of the first year, Dakon tells Jed he wants out
of the business and would like his $20,000
back—running a business, it turns out, doesn’t
give him enough time to hit the peaks. Jed
can’t figure out a way to give Dakon his
investment back without selling off badly
needed inventory at fire sale prices (and
perhaps having to close the shop). Refusing to
do this, he tells Dakon that he can’t take his
money out of the business so soon and on
such short notice. This angers Dakon—after
all, he has worked hard at low pay for almost
a year! So one night Dakon grabs what he
guesses is $20,000 worth of climbing gear from
the store, loads it into his Jeep and takes off.
On the counter he leaves a note saying that
the store now belongs 100% to Jed. Left with
inadequate inventory, Jed can’t pay the store’s
debts and has to file for bankruptcy. Of
course, Jed may have a claim against Dakon,
but with Dakon off climbing mountains in
Chile, Jed is unlikely to collect anything.
Although it’s impossible to prevent a business
associate from acting as badly as Dakon did, you
can reduce the likelihood that this will occur. You
can do this by giving a departing owner a method
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BUY-SELL AGREEMENT HANDBOOK
for getting bck at least some of his investment—if
the company is operating in the black. At the
same time, you can avoid the other extreme of
allowing an owner to demand her money back at
any time. To accomplish this, your Right-to-Forcea-Sale clause can let an owner cash in her interest
only after a reasonable period of time. For instance, your clause can require the company to
buy out an owner only when he has been an active owner in the company three years or more.
Or, your agreement can provide that if an owner
leaves before the expiration of a required time
period, the company will be required to buy him
out, but only at a lowish price (say, 50% of the
business’s appraised value). This makes it clear to
the owners that, by going into business, they are
making a financial commitment to stick it out until the business becomes profitable—if they don’t,
they may lose all or part of their investment.
EXAMPLE: Let’s reroll our cameras and give Jed
and Dakon a legal framework designed to
cope with change. Knowing that Dakon is
highly susceptible to the call of the wild, early
on Jed raises the subject of what would
happen if one of them becomes unhappy with
the business and wants out. They jointly
decide that to get the business past its start-up
pains, each must make a minimum two-year
commitment. To enforce this point, they adopt
a buy-sell provision stating that if one of them
decides to leave during the first year, the other
will buy him out at a price that is 40% of the
standard buyout price set in the agreement. If
one of them leaves during year two, he gets
60% of the Agreement Price. Only if a co-owner
stays with the business into the third year is he
eligible to force a purchase for 100% of the full
Agreement Price.
The good news is that Dakon, realizing he
is committed, hangs in for almost three years,
at which point Jed has no trouble borrowing
the money to buy Dakon’s share for 100% of
the Agreement Price.
Choosing the required time period. The
length of time you require for a departing
owner to receive 100% of the Agreement Price
can vary with your type of business. For example,
if yours is the type of business likely to take five
or more years to fully establish, you may want to
pay a departing owner 100% of her interest’s
value only after this period is over.
There are, of course, times when an owner
really needs to leave and be cashed out, as
opposed to simply wanting to bail out to do
something else. For example, an owner with a
sick child may need to move closer to a particular
medical center, or an owner whose own health is
declining may be advised to quit working. In
situations like these, should the departing owner
be subject to the same discounts that would apply
to an owner who leaves his spouse and runs off
to the Cayman Islands? If your answer is no, you
can provide that an owner who leaves for a short
list of personal or family reasons is entitled to a
better deal than an owner who leaves on a whim.
EXAMPLE: Let’s rewind one more time. Dakon
and Jed are running their climbing-gear business with a solid buy-sell agreement in place
that outlines what will happen if one of them
leaves the business. Dakon learns that his
elderly mother has severe multiple sclerosis.
He decides he has to move back east to help
out his parents. Even though he and Jed have
only been in business less than a year, Dakon
points out that in case of a serious illness of a
co-owner’s spouse, child or parent, their
agreement provides that a departing owner is
entitled to 100% of the Agreement Price for his
interest.
The language included in our buy-sell agreement that gives you a choice of disincentive
options, one with a release clause in case of
injury or illness and one without, is shown in
Excerpt 3.
PROVIDING THE RIGHT TO FORCE BUYOUTS
3/11
(b) Disincentive option
Option 2a: Disincentive period, with illness/injury exception
If a retiring owner gives notice that he or she wishes his or her ownership interest to be
bought before the end of [insert number of months, such as “24”] months of ownership
of the company, he or she is entitled to receive only [insert percentage, such as “50”] %
of the Agreement Price for the sale of ownership interests in this company under this
agreement, unless he or she is required to leave because of serious personal illness or
injury or the serious illness or injury of a spouse, parent or child, in which case he or
she is entitled to 100% of the Agreement Price.
Option 2b: Disincentive period, without illness/injury exception
If a retiring owner gives notice that he or she wishes his or her ownership interest to be
bought before the end of [insert number of months, such as “24”] months of ownership
of the company, he or she is entitled to receive only [insert percentage, such as “50”] %
of the Agreement Price for the sale of ownership interests in this company under this
agreement.
Excerpt 3
Worksheet. If you want a retiring owner to
receive a discounted price if he leaves
within a certain time period for any reason, check
Option 2a on your worksheet. (Section III, Scenario 1, Option 2.) If you want a retiring owner to
receive a discounted price if he leaves within a
certain time period, unless he is leaving because of
a personal or family illness or injury, check Option 2b on your worksheet. If you check one of
these options, also:
• insert the amount of time an owner must be
with the company before being able to sell
out for the full Agreement Price, usually at
least one or two years, maybe more
• insert the amount of the discount to be
taken off the Agreement Price if an owner
leaves before the end of the required time
period.
Payment plans can help in these situations.
Allowing a flexible payment plan, such as
an installment plan, often allows continuing owners to pay a selling owner a higher price. You may
be wondering how Jed could afford to pay Dakon
100% of the Agreement Price after being in business less than a year. The best way to accomplish
a sudden buyout without bankrupting the business is to pay a departing owner in installments
over several years. When a death or disability is involved, planning to fund a buyout with insurance
is also an option. We cover insurance funding in
Chapter 5 and payment plans in Chapter 7.
b. Requiring Advance Notice of
Intent to Leave
Another smart way to ease the burden of a forced
buyout is to require an owner who wants to quit
or retire to give the company advance notice of
her intention to leave (except in the case of death
or sudden illness or disability, of course). In some
companies, requiring as much as a six- to twelvemonth advance notice is often considered reasonable. Our agreement requires a 60-day notice.
This should be adequate time for the remaining
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BUY-SELL AGREEMENT HANDBOOK
owners to take a collective deep breath and devise a plan to buy out the owner and continue
the business. Of course, if you and your business
partners think you’ll need more notice, you can
change the agreement to reflect this.
Worksheet. If you are interested in provid-
ing for a longer notice period, make a notation on your worksheet to change this time period. (Section III, Scenario 1, Option 2, Paragraph
(a).)
Be Ready to Customize Standard
Clauses to Fit Your Situation
Throughout this book we provide technical
language and options to solve common buy-sell
situations. But since every situation contains its
own nuances, you may want to tinker with our
clauses and clause options to be sure your
agreement fits like a custom-made glove, not a
one-size-fits-all handcuff. For instance, as noted
in the text, a well-drawn buy-sell agreement
will balance the desire to protect each owner in
case of personal problems with the need to
protect the financial integrity of the business.
We’ve talked about several ways to approach
this balance. But only you and your co-owners
know what’s best for your company.
If you want to provide a market for a departing owner without overburdening the company
and aren’t satisfied with the options we suggest,
such as requiring advance notice, a lower price
for leaving early and an installment payment
plan, you can create your own contractual
language. For example, a customized Right-toForce-a-Sale provision might state that the
departing owner must first try to find an outside
buyer who is acceptable to the other owners.
Assuming no buyer comes forward after six
months, your agreement could then provide
that the company or the continuing owners
must purchase the departing owner’s interest, at
a price discounted by 20% of the full Agreement Price. This discount gives the departing
owner some incentive to find an outside buyer
first, and lessens the immediate financial burden on the company and remaining owners.
PROVIDING THE RIGHT TO FORCE BUYOUTS
C. What If an Owner Becomes
Mentally or Physically Disabled?
The next business-disrupting event we consider
and help you plan for is the possibility that an
owner becomes disabled. Disability, of course,
includes physical injuries and illnesses, but also
can be caused by mental illness, such as clinical
depression, Alzheimer’s disease and other forms
of dementia or incapacity. Below, we discuss how
your agreement can deal with the tricky question
of whether an owner is truly disabled.
Disability and retirement buyout clauses
should be looked at together. If an owner
feels he cannot work and wants to be bought out,
but does not fit under a doctor’s or the disability
insurance company’s definition of disability,
arguments can arise. These conflicts can often be
defused in advance if you have also adopted a
clause allowing an owner to force a sale due to
retirement (discussed in Section B2, above).
1. Option of Company and Continuing
Owners to Purchase a Disabled
Owner’s Interest
What happens if an owner becomes injured,
develops a chronic illness or is otherwise unable
to participate in company affairs for an extended
period of time? If the owner is an investor and
was never involved in the day-to-day operations
of the business, the answer may appropriately be
“nothing”—after all, it probably makes little difference to the company whether an inactive investor
is or isn’t disabled.
But assume the owner has been active in the
business and takes a salary or regular draws from
it. For an owner who can no longer work but
takes money out of the company, there are obvious reasons why the other co-owners might
sooner or later want to replace her. Of course,
after a decent interval the co-owners could stop
the salary of the disabled owner (who, after all, is
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no longer earning it), but allow him to continue
to own his share of the business. But the co-owners of a small company may not want to share
future successes and management decisions with
an owner who is no longer adding anything to
the company. In this situation, the co-owners
might want the right to buy out the disabled
owner.
Absent this right, there can be highly emotional
disagreements when a disabled owner does not
want to be bought out (he may even disagree as
to whether he is unable to perform his duties). It
is because of the debilitating nature of these
disputes that you need to have a disability-triggered buy-sell provision in place. Your agreement
can include a clause that allows the company and
the other owners to require a disabled owner (or
the owner’s conservator, guardian or other legal
representative) to sell her ownership interest back
to the company or to the other owners on demand. This protects the nondisabled owners of
the company from having to share management
with someone who can’t handle the requirements
of the job, or simply from having to support that
person.
EXAMPLE: George has been a partner of a
printing company for ten years, along with his
longtime friends Martha and Stew. Now in his
70s, he frequently experiences significant lapses
of memory. More than once his forgetfulness
has led to an unfinished job, and unhappy
clients have begun to whisper to Martha and
Stew that they no longer want to work with
George. George admits he is sometimes forgetful, but he insists that he is fit to continue
working. But when they almost lose their biggest client, Stew and Martha face the truth that
George is not mentally up to continuing to
work. Since George is a general partner
entitled to an annual share of the company
profits, the only sensible way to stop him from
receiving 1/3 of the company’s profits is to ask
him to sell out. But when confronted by Stew
and Martha, George refuses, threatening to get
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BUY-SELL AGREEMENT HANDBOOK
a lawyer. Martha and Stew rue the day, ten
years before, when they didn’t insist on a buysell agreement dealing with disability as a condition of starting the business.
Not for silent investors. If your company is
owned by both inactive, “silent” investors
and actively participating owners, this buyout
option may not suit your needs. (If an investor
was not working in the first place, disability should
not necessarily give him the right to force a
buyout of his interest.) Again, since most of our
advice is tailored to small businesses where the
owners are active in the business, we don’t deal
in detail with the special needs of investors. If
you face this situation, be sure to have an attorney
look over your agreement. We cover finding
expert help in Chapter 10.
Before you decide to adopt a disability provision, you’ll want to ask: Will the company or the
nondisabled owners be able to come up with the
money to buy a disabled owner out? After all,
most small to mid-sized businesses need every
penny they can scare up to maintain or expand
their business—they don’t have a ready store of
cash to fund a buyout. One way to cope with this
problem is to call for a long-term installment plan,
allowing the company or continuing owners to
make partial payments to a disabled owner over a
number of years.
But for larger companies, especially, there is a
better way to cope with this issue that doesn’t
make the disabled owner wait many years to be
paid off for her interest. Your buy-sell agreement
can require the purchase of disability insurance
for all co-owners. This way, if a disability occurs,
the insurance policy proceeds will provide a
source of funds to allow the company or the coowners to buy back the interest of a disabled
owner without diminishing company or personal
cash reserves.
If desired, additional financial benefits such as
a wage continuation plan for the disabled owner
can also be funded by disability policy proceeds.
(We discuss using insurance to fund your agreement in more detail in Chapter 5.)
Next, a big issue you’ll have to face is when an
owner is truly disabled. Our agreement specifies
that the owner must be “permanently and totally
disabled”—unable to perform most or all of his
duties. Our agreement also includes a procedure
to determine when an owner is considered disabled—using the opinion of the owner’s doctor.
Or, if your agreement will require disability insurance to fund the buyout of a disabled owner (discussed briefly below and in more depth in Chapter 5), the agreement provides that the insurance
company is the arbiter of whether the co-owner
really is disabled. (An added bonus of going that
route is that the other owners will be relieved of
the burden of supervising the disability claim and
asking the disabled owner for medical evidence
of a disability.)
There are several additional issues you should
consider to ensure that your disability clause has
the maximum chance of working well:
• Your agreement establishes a period of
time—a waiting period (or, in insurance
lingo, an elimination period)—over which
an owner’s disability must persist before a
buyout can occur. This allows for the fact
that the owner might recover. We recommend
that your waiting period be at least six
months, or perhaps as long as a year. A
buyout attempted before it’s really clear that
the owner probably won’t recover can result
in bitterness and wasted time and money,
especially if the former owner recovers. Our
agreement provides that time spent off work
by an owner with a series of illnesses with
the same or related causes can be added up
to fulfill the waiting period requirement.
Otherwise, requiring six months to a year of
continuous inability to work might discourage an injured or ill individual from returning to work if he’s feeling better (perhaps to
test whether going back to work would be
feasible). Of course, if your agreement will
require the purchase of disability insurance